Author: Ramsi Woodcock

Categories
Tax

Why the Asymmetry between the Income and Consumption Taxes?

In what was, I think, the only math course I took in college, the professor said: “when you are trying to solve a problem, look for the asymmetries and ask: why? Asymmetries happen for a reason, and if there is no reason, then the asymmetry shouldn’t be there.”

It is a staple of tax theory that the income tax touches both labor and investment income whereas the consumption tax touches only labor income.

Why this asymmetry?

The Conventional Account

The standard explanation sheds no light on the question. It goes like this.

Suppose that you work for a period l at wage w, invest the resulting income of wl at interest rate r, and then spend the proceeds.

Under an income tax of rate t, you will pay twl in tax on your labor income, leaving you with wl-wlt=wl(1-t) remaining to invest. Your investment will grow to wl(1-t)+wl(1-t)r=wl(1-t)(1+r), but the interest earned on the investment, wl(1-t)r, counts as income as well, so it, too, will be taxed at rate t. You will therefore pay twl(1-t)r in additional tax, leaving you with wl(1-t)(1+r)-twl(1-t)r=

    \begin{align*} wl(1-t)(1+r(1-t)) \end{align*}

to spend after all taxes have been paid.

By contrast, under a consumption tax, you will be able to invest all of your labor earnings, wl, to obtain wl(1+r) after your investment pays out. Assuming that the income and consumption tax rates are the same, you will then pay tax twl(1+r) when you go to spend your income on consumption items, leaving you with a total of wl(1+r)(1-t)=

    \begin{align*} wl(1-t)(1+r). \end{align*}

The expressions for the income tax and the consumption tax both have a tax term, 1-t, applied directly to labor income, wl, suggesting that they both tax labor income in the same way. But the expression for the income tax also applies the same 1-t term to the rate of return on investment, r, which the expression for the consumption tax does not. This suggests that the income tax taxes investment returns whereas the consumption tax taxes only labor income.

Indeed, if we construct an expression for an income tax that applies to labor income but not to investment income, we end up with our expression for a consumption tax.

We start with labor income wl and then apply a tax of twl, as we did in analyzing the original income tax, to obtain wl(1-t). This amount is again invested to obtain wl(1-t)(1+r). But now we are done—we do not apply a tax on investment returns. The result,

    \begin{align*} wl(1-t)(1+r), \end{align*}

is identical to the expression that we obtained for the consumption tax.

We must, then, conclude that a tax on consumption taxes only labor income whereas the income tax taxes both labor income and investment income. (The table at the end summarizes after-tax value under this and a number of other scenarios that I will discuss.)

Why this asymmetry?

It is not intuitive.

A consumption tax is a tax on money going out, whereas an income tax is a tax on money going in. If everything that comes in must eventually go out, should not the income tax and the consumption tax be identical?

If the money the worker spends on consumption was generated in part through financial investments, shouldn’t a tax on everything he spends (i.e., on consumption) end up taxing the return on investment as well as labor income?

If there is no good reason for an asymmetry, then it should not be there.

If it should be there, then we have not really understood tax policy until we have understood why the asymmetry is there.

It turns out that the conventional account of the difference between consumption and income taxation both ignores a broader symmetry between the two approaches and is equally mum regarding a good reason for the asymmetry.

A Latent Symmetry

Let’s start with the broader symmetry that the conventional account omits.

Our method will be to try to find—or construct—symmetry between the income and consumption taxes. If we can figure out what we need to make the treatments symmetrical, we can then ask whether the absence of the things that are needed for symmetry is justified.

Comparing Workers with Rentiers

The first thing to realize is that the conventional account jumbles the tax treatment of labor income together with that of investment income. It tells the story of a laborer who starts with labor income and then invests it, suggesting that all income originates in labor. It starts with wl.

But not all of us are so unfortunate.

Some people don’t work—don’t have to work—because they get all of their income from financial investments.

The money they invest is so great that the return it throws off is large enough to make them prefer not to work for labor income.

There’s an old word for such people: rentiers. As Piketty has shown, they are making a comeback.

To avoid any quirks in tax treatment created by jumbling the experience of the rentier together with that of the worker, let’s consider the worker who gets all of his income from labor and the rentier who gets all of his income from investments—rather than consider a worker who plays rentier with his labor income, as in the conventional account.

Let’s look first at the rentier and the income tax.

The rentier has some financial endowment—call it p for property—which he grows to p(1+r)=p+pr through investment. At this point, the income tax is applied to his interest income, pr, and he is taxed the amount tpr. This leaves him with p+rp-tpr=

    \begin{align*} p(1+r(1-t)). \end{align*}

We see that the effect of the application of the income tax to investment returns reduces the after-tax growth rate of the investment from r to r(1-t).

Now let us consider the experience of the workers under the income tax when he does not invest his earnings in financial assets.

In that case, the worker earns wl, pays tax on it, and does not invest, ending with

    \begin{align*} wl(1-t). \end{align*}

The income tax treatment of the worker clearly differs from that of the rentier. We should be surprised that they do.

The income tax taxes both labor income and investment income at the same rate t, and here we have a rentier who has generated only investment income and a laborer who has generated only labor income. Shouldn’t the two be taxed in the same way?

The answer holds the key to our problem.

We can find it by continuing to try to construct symmetry between the treatment of the rentier and the worker.

One way to do that would be by eliminating the 1 term in the parentheses in our expression for the rentier’s after-tax income. That would give us pr(1-t), which is analogous to the expression for the worker’s after-tax income, lw(1-t).

But doing that would not make any sense. Eliminating the 1 is equivalent to making the claim that when you invest an amount p you obtain interest on your investment, pr (which is then taxed to obtain pr(1-t)), but not the return of the amount you invested, p.

But that’s not how finance works. When you invest an amount, you don’t lose your capital and gain only the interest paid on it. Instead, you get your capital back, plus interest.

We can also create symmetry by adding a 1 to the expression for the worker’s after-tax income, to obtain

    \begin{align*} l(1+w(1-t)). \end{align*}

Here is where things get interesting.

Labor as Capital

Adding that 1 in makes the claim that labor income, wl, is equivalent to the interest paid on an investment of working hours l. The worker invests l by working, and that investment grows into l(1+w)=l+wl, the worker’s l hours of work plus labor income wl.

But the “labor capital” that the worker has invested, l, is not taxed, only the return on that capital, wl, is taxed, just as, in the case of financial assets, the capital, p, is not taxed, and only the return on capital, pr, is taxed. As a result, the worker pays twl on value of l + wl, and ends up with l+wl-twl=l(1+w(1-t)), our symmetrized expression for labor income.

That is, with this change, the wage, w, becomes the analogue of the interest rate, r—it becomes the rate at which labor is compensated, just as r is the rate at which investment is compensated. And the number of hours worked, l, becomes the analogue of the dollar amount invested, p—it becomes the amount of labor with which the worker is endowed, just as p is the amount of investment capital with which the rentier is endowed.

But what does it mean to say that a worker invests l hours of labor and receives those l hours plus a return equal to labor income in exchange?

Of course, if one works l hours, one never gets those hours back again. Perhaps one receives the satisfaction of having worked l hours of honest labor alongside one’s income on that labor.

Or the l hours represent one’s ability to work over a given period of time, and, as this ability does not diminish from one period to the next, at the end of each period one starts over afresh with the same amount of hours on hand to invest in labor.

We do not need to resolve this question, however, because, for purposes of comparing consumption and income taxation, the nature of a labor hour matters only to the extent that this affect’s the hour’s exchange value. But labor hours have no exchange value.

Labor hours cannot be transferred.

One’s labor time is personal to oneself.

Only I can can expend my hours on work because only I have those hours.

You can pay me for my work—that’s the return that you pay me on my investment of my time in laboring for you—but you yourself cannot work my hours. If I could transfer my hours to you, then you could work 24 or 48 or 72 hours in a single day, for you could work my hours and your own ours and the hours of others.

But that, of course, is impossible.

I am a capital asset that only I can use.

Because labor hours cannot be transferred, they have no price. They cannot be exchanged for cash, cannot be spent on consumption goods or services, and cannot be taxed.

When we speak of financial investment, we speak of p(1+r) and when we speak of labor, we ought to speak, analogously, of l(1+w).

That is, we should think of labor hours in the same way as we think of financial assets, and we should therefore think about the taxation of labor income in the same way as we think about the taxation of investment income.

When we tax investment income, we don’t tax the financial asset that is invested—we don’t tax “savings”—but only the interest on that asset—the return on investment.

Just so, when we tax labor income, we don’t tax the labor asset that is invested—those labor hours—(how can we?) but only the interest on that asset, which is the interest rate—here called the wage—applied to the asset in the form of hours worked. That interest on the labor asset is otherwise known as labor income.

Thus the rentier’s after-tax investment value is p(1+r(1-t)) and the worker’s after-tax investment value is, similarly, l(1+w(1-t)).

But in the case of the worker we don’t write down l(1+w(1-t)) and instead write down wl(1-t) because the fact that l is not transferable, has no cash value, can’t be spent on consumption, and can’t be taxed causes us to forget that it is there.

Financial capital is a transferable thing—it’s dollars and cents, or things that can be exchanged for them—-and we can and do tax it and consume it. The existence of p is therefore constantly before our mind’s eye and we do not omit to write p(1+r(1-t)) rather than, analogously to the worker’s case, pr(1-t).

But what does this hidden symmetry between the income tax as applied to the rentier and the income tax as applied to the worker tell us about the asymmetry that we set ought to conquer, which is the asymmetry in the consumption tax treatment of labor and (financial) investment?

That answer is: a lot.

It shows why the asymmetry exists.

Eliminating the Asymmetry by Treating Labor as Capital

For if we acknowledge that labor income is the return on an investment of labor time, and if it were possible to transfer one’s endowment of labor hours, l, so that it could be taxed or consumed, just one’s endowment of financial assets, p, can be taxed or consumed, then the consumption tax would no longer be equivalent to a tax on labor income; it would differ both from a tax on labor income and from a tax on investment income and would differ from both in the same way.

Thus the asymmetry between the consumption tax treatment of labor and investment income would be eliminated.

If we acknowledge that labor income is the return on labor hours, and if one’s labor endowment were transferable—and so taxable and consumable—then a worker who generates labor income but does not invest in financial assets would generate value equal to l(1+w) from working and then pay tax tl(1+w) on this value, leaving the worker with consumption equal to

    \begin{align*} l(1+w)(1-t). \end{align*}

But, as we have already seen, under the income tax, the worker’s after-tax value would be l(1+w(1-t))—it would differ from value under a consumption tax in that the factor 1-t would be applied to the wage instead of to the entire investment.

And precisely the same would be true of the income and consumption taxes with respect to financial investments.

We have already seen that under an income tax the rentier’s after-tax value would be p(1+r(1-t)). Under a consumption tax, the rentier would invest p, obtain p(1+r), and then pay the consumption tax on that amount, leaving p(1+r)(1-t). Thus, here again, the difference would lie in the application of the factor 1-t to the interest rate (the analogue of the worker’s wage) in the case of an income tax. The table at the end summarizes these results.

It follows that, as a general matter, we cannot say that the consumption tax taxes labor income but not financial income.

The conventional account is not generally true.

The consumption tax is neither a tax on labor income nor a tax on financial income.

Rather, in principle, it is a tax on wealth—it taxes both the return on capital and the capital itself, whether that capital is labor capital or financial capital.

Because all wealth—the capital and the return on capital—must, ultimately, be consumed.

We also see from this analysis that the income tax and the consumption tax are not the same, whether applied to labor income or financial income. The income tax taxes the return on capital whereas the consumption tax taxes both capital and its return.

The answer to the question how a tax on what goes in can differ from a tax on what goes out is that what goes in is not just income but rather wealth—capital plus returns thereon—and so an income tax will not fully cover it. Thus the tax on what goes out—the consumption tax—which does cover everything that goes out, will differ from the income tax.

The Untransferability of Labor Hours as the Source of the Asymmetry

So much for the general structural symmetry of the income and consumption taxes. We must now ask why the conventional account finds asymmetry.

Is the conventional account simply mistaken, or is there a reason why, in practice, we must depart from the general structure?

It turns out that we have already encountered the answer. There is a good reason why, in practice, there is asymmetry. That reason is the untransferability of labor hours.

We cannot, in fact, say that under a consumption tax the after-tax value enjoyed by a worker is l(1+w)(1-t), because that equals l(1-t)+w(1-t), implying that the tax authority taxes tl labor hours, and the worker consumes l(1-t) labor hours.

But that’s impossible, because those hours can’t be transferred, either to the government or anyone else.

Unlike the rentier, who, at the end of the day, spends both his investment capital and his returns on consumption, the worker cannot spend his labor hours on consumption because he cannot trade them. He generates cash for consumption only through the returns he generates on his labor, which are paid to him in dollars or other tradable commodities.

His value after application of the consumption tax is, therefore, his labor income—his return on his labor hours—wl, less a tax twl on those returns, or wl(1-t), plus his labor capital, l, which he still holds, even if he cannot trade or consume it. So it is l+wl(1-t)=l(1+w(1-t)).

But that makes the consumption tax identical to the income tax—the same identity found by the conventional account. For we have already seen that under the income tax, he is left with l(1+w(1-t)), and as the income tax touches only labor income, wl, the fact that he cannot transfer his labor hours does not change the analysis.

Financial assets are consumable, however, and so the nonconsumability of labor hours counsels no change to our expression for the rentier’s value after application of the consumption tax. It remains p(1+r)(1-t) and so remains different from the expression for the rentier’s value after application of the income tax, p(1+r(1-t)).

So far from failing to tax financial capital, the consumption tax in fact does tax it—p(1+r)(1-t)=p(1-t)+rp(1-t), so financial capital, p, is reduced by 1-t—and it is the fact that the consumption tax taxes financial capital, while not taxing labor capital, that accounts for the difference in the way the consumption tax treats the two forms of endeavor.

Thus the nontransferability of labor introduces the asymmetry between the treatment of labor and investment income by the consumption tax that we see in the conventional account—and this is evident even without telling the story about the reinvestment of labor income in financial assets through which the conventional account makes this point.

The conventional account does not, of course, say that the worker’s after-tax value is l(1+w(1-t)), but rather that it is wl(1-t)(1+r). That is because the conventional account doesn’t recognize that labor hours are labor capital—or doesn’t care whether they are, because they are nontransferrable—and so doesn’t bother to write down the 1 in l(1+w) when it writes down the worker’s starting income. The conventional account omits the 1 and writes down wl instead. According to the conventional account, the worker’s wealth is exclusively his return on labor capital.

And, as already noted, the conventional account goes on to imagine the worker playing rentier and investing his labor income in financial assets. Thus, in the case of the consumption tax, the worker’s income is invested in financial assets and grown to wl(1+r) before being taxed down to wl(1+r)(1-t). So, in the conventional account, wl is in effect substituted for p in our expression for the rentier’s after-tax value of p(1+r)(1-t).

Similarly, in the income tax context, we have labor income of wl that is taxed down to wl(1-t) and then ploughed into financial investments. So wl(1-t) is substituted for p in our expression for the rentier’s after-tax income, p(1+r(1-t)), to obtain wl(1-t)(1+r(1-t)), the familiar result of the conventional account in the case of an income tax.

We can now restate what we have learned in terms of the conventional account.

The fact that after-tax value under a consumption tax in the conventional story has the same form, wl(1+r)(1-t), as a tax on labor income (that is then invested tax free), wl(1-t)(1+r), is not due to any failure on the part of a consumption tax to tax investment returns. After all, wl(1+r)(1-t)=wl(1-t)+wlr(1-t), so investment returns wlr are taxed down to wlr(1-t).

Rather, it is due to the fact that labor time, l, is not taxed under a consumption tax. If it were, then, adding 1+r terms (to reflect financial investment) to the expressions we generated for the worker above, we would find that the after-tax value expression under a consumption tax would be l(1+w)(1+r)(1-t), whereas the expression for a tax on labor income that is then invested tax free would be l(1+w(1-t))(1+r), which is a different quantity. It is only by deleting the first 1 to be found in each expression that they collapse into each other. (Equivalently, we could render labor hours untaxable—pulling the first 1 in the case of the consumption tax out of the parentheses—as we did above, and achieve the same result.)

Taxing Capital Would Restore Symmetry

Let us return to our simpler comparison of the tax treatment of worker and rentier in which the worker does not plow his earnings into financial assets.

Our understanding of the source of the asymmetry in consumption and income taxation helps us see how to eliminate it.

We have seen that the key to the asymmetry is that the consumption tax taxes capital and the income tax does not, but labor capital is untaxable, so the consumption tax and the income tax collapse into each other in the case of labor income—but not in the case of financial income.

The way to make the income tax equivalent to the consumption tax is, therefore, to redefine the income tax to apply to financial capital.

Make the income tax a wealth tax.

That would make the consumption tax as applied to investment income the same as the income tax, and the consumption tax and the income tax would, then, be equivalent both when applied to labor income and when applied to investment income.

Because no amount of redefinition of tax rules can make labor hours transferable, such a wealth tax would not apply to labor capital, and so the income tax as applied to labor income and the consumption tax would continue to be identical for practical purposes.

But now the income tax as applied to financial investments would be identical to the consumption tax, for now the rentier would pay tax both on p and his return rp, and so he would have his investment outcome, p(1+r) less tax tp(1+r), or p(1+r)(1-t), and the consumption tax on the rentier’s investment outcome would be the same as the income tax that he pays—tp(1+r)—leaving the rentier with the same after-tax value of p(1+r)(1-t).

This situation is slightly more complicated when we translate this insight back into the conventional account, because in the conventional account the worker is also the financial investor.

The conventional account’s expression for the income tax applied both to labor and financial income, wl(1-t)(1+r(1-t)), differs from that for the consumption tax, wl(1+r)(1-t), in two ways.

One is that the second 1-t term is applied directly to r rather than to the entire expression. The fix of taxing financial capital solves this problem. The worker’s financial capital—wl(1-t)—would, then, be taxed alongside the return on that capital, rwl(1-t), and so we would have after-tax value of wl(1-t)(1+r)(1-t), bringing the expression closer to that for the consumption tax.

But that still leaves the first 1-t term as an extraneous term. That term is present because the worker uses his labor income for purposes of financial investment and his labor income is taxed when it is earned. In effect, the worker who invests would be taxed twice under a wealth tax. Once when he generates labor income and again when he converts that labor income to financial capital and invests it.

This is the sort of problem we were able to ignore in comparing the experience of the worker with that of a separate rentier.

The income and consumption taxes can be brought into equivalence by recognizing a deduction for labor income that is invested in financial markets, in which case the worker will invest wl instead of wl(1-t), and the worker’s after-tax income will therefore become wl(1+r)(1-t)—identical to that for the consumption tax.

Labor income that is earmarked for investment is properly treated as investment capital, and so it should be taxed after it is invested, not when it is first acquired. If we tax labor income that is earmarked for investment, then we should tax all financial assets at the time that they are acquired—that is, before they are invested—and then again when the investment pays out.

The proposed fix to the asymmetry in consumption taxation—taxing financial capital and deducting labor earnings that are invested in financial markets—has a name: it is called a “cash-flow consumption tax.” The fact that it is called a consumption tax and not a wealth tax, even though it is collected when cash flows in rather than when it flows out, is an acknowledgement that this sort of tax on inflows is equivalent to a tax on outflows.

The Radicalism of the Consumption Tax

Defenders of the income tax (as presently defined) like it because it taxes more. Under the conventional account, after-tax income under the income tax is wl(1-t)(1+r(1-t)), which is less than after-tax value wl(1+r)(1-t) under a consumption tax because an additional 1-t term is applied to the interest rate, r, under the income tax.

But after-tax income is lower under the income tax only because, under the conventional account, labor income is taxed once before it is invested, and that happens only because the conventional account assumes that a financial investor’s source of income is labor.

For the rentier, the situation is reversed. We have already seen that the rentier subject to an income tax ends up with p(1+r(1-t)) in after-tax income whereas the rentier subject to a consumption tax ends up with p(1+r)(1-t). In the latter expression, the 1-t is outside of the parentheses—reducing the entire magnitude contained in the parentheses—and so after-tax income is lower than in the case of the income tax. That is because the rentier pays tax on his financial capital, not just his returns.

Because the consumption tax is a wealth tax; it is more radical than the income tax.

The truly rich, who do not work but live off of their financial assets, do worse under a consumption tax than under an income tax.

It is only the worker, who scrapes together savings to invest in financial markets, who ends up being taxed more heavily under the income tax than under the consumption tax.

That same math teacher who taught me to question asymmetries also liked to call out students who weren’t paying attention in class. “Are you an angry young man?”, he would ask.

I’m not.

But I would like to tax the rentier’s capital.

ScenarioIncome TaxConsumption Tax
Worker income invested (conventional account)wl(1-t)(1+r(1-t))wl(1+r)(1-t)
Worker value (transferable labor)l(1+w(1-t))l(1+w)(1-t)
Rentier value (transferable labor)p(1+r(1-t))p(1+r)(1-t)
Worker value (untransferable labor)l(1+w(1-t))l(1+w(1-t))
Rentier value (untransferable labor)p(1+r(1-t))p(1+r)(1-t)
Worker value (labor capital ignored)wl(1-t)wl(1-t)
Rentier value (labor capital ignored)p(1+r(1-t))p(1+r)(1-t)
Worker income invested (conventional account with cash-flow consumption tax instead of income tax)wl(1+r)(1-t)wl(1+r)(1-t)
After-tax income under various scenarios.
Categories
Meta Regulation

The Other Conflict of Interest and the Root of Inequality

It is common in the study of corporate governance to worry about the conflict of interest between shareholders and managers. Managers are supposed to run the firm to maximize shareholder value, but because they run the firm on a day-to-day basis, not the shareholders, they have plenty of opportunity to enrich themselves are shareholder expense. Others worry that the power of shareholders and managers over firm governance enables them to cheat creditors, workers, and sometimes even suppliers.

But there is another interest that no one ever talks about, and which is even less able to defend itself than are shareholders against managers, or creditors, workers, or suppliers against shareholders and managers.

That is the firm itself.

The firm is not its shareholders. It is not its managers. It is not its workers, creditors, or suppliers.

It is a fiction in the sense that a firm always is a fiction, a thing that exists only because shareholders, managers, workers, creditors, suppliers, and the government act like it exists. It has no flesh and no blood. It cannot be found anywhere; or, rather, it is located wherever the law says that it is located rather than where the laws of physics place it.

But it has a name: the name of the business.

It can open bank accounts.

It can own property.

It can sue.

It even has a right not to be deprived of life, liberty, or property without due process of law.

The firm exists in the way that the mime’s wall exists. There is nothing there, but his hand stops as if it were there.

Just so, the corporation exists because we speak as if it exists. Because we find all of our legal institutions bending around its form as if there were something there to bend them.

And yet, despite all the care that we take to act as if there really were an independent, living, breathing thing that is the firm, when it comes time to count up conflicts of interest, we never talk about the conflict between the interests of shareholders, managers, workers, creditors, and suppliers—and the firm itself.

We recognize that there must be such a conflict, and we even have an entire body of law—agency law—devoted to protecting the firm itself against managers and employees who put their interests before the firm’s. We say that managers and employees have duties of loyalty and care to the firm.

And yet we seem hardly able to take such duties seriously, or, at any rate, fully to appreciate that they are owed to the firm—to the mystery, to the fiction, to the hollowness beneath the mime’s hand.

We say that the board of directors owes a duty to the firm, but we think that the duty is really owed to the firm’s shareholders, or to its workers, or to whatever set of actual, living, breathing persons are ultimately harmed by the cupidity of the firm’s agents.

We comply with the fiction that managers and employees owe their duties to the firm by describing the shareholders who sue careless or disloyal managers as filing a “derivative” lawsuit on behalf of the firm. The shareholders have no direct claim against the wrongdoers, we say, because the wrong was done to the firm and not directly to the shareholders.

And we comply further by asking that any recovery be paid first to the firm as compensation for harm to the firm and only thence to shareholders.

But we experience this part of the fiction of the corporate person as unnecessary. Nothing would be lost were shareholders to be permitted to sue managers directly.

We are wrong to do that.

If we were actually to take conflicts with the firm seriously, we would come to a very troubling thought indeed: that the mute, defenseless fiction that is the firm is surely the worst victim of self-interested behavior of all.

Conflicts run deepest not between shareholders and managers, or even between managers and workers, but between all of these groups and the firm, because of all of these groups only the firm lacks a physical presence and hence even the slightest semblance of autonomy. The firm exists entirely in the unseen world behind the world, and speaks only through the very groups—the shareholders, managers, workers, and so on—from which the firm needs protection.

And the firm does need protection because the firm’s interests are necessarily always in conflict with those of shareholders, managers, workers, and all the other counterparties of the firm.

Because the firm never dies. It alone is in business for the long term and the long term interest is almost always in conflict with the short term interests of mere mortals.

Imagine that a firm generates a billion dollars in net income and that maximizing the long-term—as in over the course of the next two centuries—profits of the firm can be achieved only by investing that billion in clean energy technology.

It is easy to imagine that no flesh and blood humans associated with the firm might be interested in actually investing the money. The shareholders might want it paid out as dividends (they want to party). The managers might want it paid out in executive compensation (they want to party). The workers might want it paid out in retirement benefits (they want to party). The creditors want their debts paid. The suppliers want higher contract prices.

The the profit-maximizing firm—yes, the firm, that metaphysical life force, that abstract interest—would want the money invested and, if all the assumptions of general equilibrium theory hold, the fact that the profit-maximizing firm would want the money invested implies that investing it is necessary for the efficient operation of the economy. It is required to maximize economic growth and otherwise to launch society forward to the greatest extent possible.

But the firm with not invest the money. Because the flesh and blood humans who control what the firm does, who are agents to the firm’s fiction, mimes to its hollowness, don’t want that to happen. The door might want to be opened, but the mime will shut it.

The money will be spent instead on shareholders, managers, workers, creditors or suppliers, and both the firm and the economy will be smaller for it in the long run.

What’s more—and this is important—legal duties will have been breached by this failure to invest. Management will have violated the duty of care, which requires managers to operate the firm with a view to maximizing the firm’s long-term profits.[1]

But no one will sue.

Shareholders will not bring a derivative suit on behalf of the corporation—they wanted to be paid.

Competition will not force the firm’s agents to behave—lest competitors take the firm’s market share and put the agents out of their jobs—because the consequences of a failure to invest for the long term manifest in the long term.

One can only imagine how much bigger the economy would be, and how much more successful the firms in it, if the conflict of interest between the firm itself and its agents were not to exist. Or if there were some way of protecting firms against it.

Imagine all the investments that have not been made throughout history because those in control of firms preferred consumption to saving.

One gets the barest hint of how bad the problem must be in the hysterical objection of business elites to mid-20th-century price regulation in industries such as telecommunications, air transport, and energy distribution. Or the hysterical objection of business elites today to attempts to limit the scope of patent grants in order to prevent windfall gains from intellectual property.

The government, businessmen argue, systematically sets prices—or, in the intellectual property context, rewards—too low, because it fails to take into account all of the investment that must be made in the future of a business.

Firms must invest in research and development.

They must insure against risk.

And so, businessmen argue, what looks like profit really is not profit, but rather a cost of long-term survival and flourishing of the firm.

Ah, but if that is the case, if we cannot trust rate regulators adequately to determine how much must be spent for a firm to flourish, why should we be able to trust shareholders or managers to do that either?

It is not, after all, in their interest to carry out that analysis faithfully, for they can never have an outlook quite as long as the firm’s.

If we think that rate regulation was bad for American business in the mid-20th century, or that stinginess with the patent grant is a big problem for the dynamism of the American economy, we must—must, must—wonder just how bad the totally unaccountable dominance of flesh and blood over fiction, of the agents over their dumb master, must be for American business.

How much less is invested than optimally should be?

This, it seems to me, explains much—not just about a structural inefficiency in the economy but also about the structural maldistribution of wealth.

Why is it that the captains of industry are so rich? Is it just that they control scarce resources? Or that they have some monopoly power? Those are, to be sure, causes.

But I wonder whether the most important is not, quite simply, that they underinvest—and keep the difference for themselves.

When I was in high school, I ran an assassin game with a classmate. I ordered some very cheap waterguns direct from China. We asked every student to pay $30 to participate in the game. We gave each student a cheap water gun and the winner $200 as reward.

There were perhaps thirty participants, which made the game very profitable.

I was so embarrassed about this windfall that I let my surprised coventurer keep all of the profits, which he used to take a trip to Europe.

I was afraid to profit and he rejoiced in it. But the point is that both of us thought of the windfall as profit.

But was it? Neither he nor I thought for minute about the interests of the business.

Perhaps the best thing for our assassin business would have been for us to invest that money in the following year’s game. We could have increased the reward, attracting more participants. We could have ordered better guns. We could have organized a joint game with another school. Whatever.

But while these were the interests of the business, they were not our interests. The business was mute; and so we ignored it.

One sees this also, I think, in how homeowners treat their houses. It is very often the case that a person will buy a house that he would not be willing to rent because the rent would be too high.

Perhaps the house is very large, or there is a shortage of rental units in the area. Whatever the case, when a person owns and lives in a house that he would not be willing to pay to rent, he is putting his own interests as a customer and indeed shareholder (i.e., owner) of the space-selling business that is his home before the interests of the business itself.

His home could generate greater profits by being rented out and indeed those profits could be invested to improve the home or expand the business to include other properties, making the business and the economy better off.

But none of this happens because the flesh and blood person who controls the business would rather forego (read: consume) the profits that could otherwise be generated by renting to others—and which would lead to long-run profits—in order to enjoy the pleasure of living in a big house, or in the right neighborhood, or what have you, right now.

Once you understand the problem, you see it everywhere.

The owner of my car repair shop was kind enough to give me a lift in his personal, very expensive vehicle while I was getting my oil changed. What portion of the purchase price of that car should he have reinvested in his business? We will never know.

Indeed, one wonders what proportion of all the executive compensation, all the share buybacks, and all the dividends paid out to owners over the past few decades—payouts that turned an L-shaped postwar inequality curve into the U-shape of Piketty fame—should optimally have been reinvested in the firms themselves.

That is, one wonders whether, if the fiction that is the firm were real and could defend itself, captains of industry would be no richer than the rest of us, and the economy a whole lot larger.

One might think that the solution is for the state to step in to protect business fictions against their flesh and blood agents.

And perhaps that is right. We need regulation not just to protect consumers against grasping firms, or shareholders against grasping managers, but to protect firms—those helpless fictions—and indeed the economy entire, against all of the grasping human agents that constitute the sum total of a firm’s human capital.

But it might just as easily be right to say that unregulated firms produce more even after taking into account how much less they produce than they might thanks to the cupidity of their agents and the helplessness of the firm.

Regardless, we must see firms as almost always victims of their human controllers. And the wealth of those controllers as almost always funded in part not just by rents—revenues in excess of costs—but by theft in the form of underinvestment in their businesses.

It might well be that, in an optimally efficient world, every businessman would eat one meal a day and darn his own socks, for that is the real minimum that a businessman would accept in exchange for doing business.

And the profits that remain are best reinvested by firms in their own futures.

Notes

[1] Yes, the duty of care is subject to the business judgment rule, which means that courts defer to the judgment of managers regarding what actions will maximize profits, and so, in practice, even were shareholders to sue, it would be very difficult for them to win such a case. But the business judgment rule is meant only to give managers the benefit of the doubt. It does not make legal actions that are known in advance to fail to maximize profits. Indeed, in a world in which there were never any doubt regarding what course of action would maximize profits, the business judgment rule would count for nothing and a manager’s failure to take the known profit-maximizing course of action would give rise to immediate liability.

Categories
Miscellany

The Author as Adversary at Iowa Law Review

If there were a law professor named Frankenstein, what would his creation be?

Maybe Iowa Law Review.

Rather than treat me as a partner in publishing an article of mine that the journal accepted back in 2019, the journal treated me as an adversary—just as people treat each other in the materials that we teach in law school.

First, an editor played the sort of power game with me that parties to litigation use against each other. He threatened to publish the article without my consent because I was late turning in revisions. That caused me to submit a final draft that was rough at best.

When I later told the editor-in-chief what happened, the journal doubled down, telling me I was the only one at fault, refusing to update the article in the legal databases to a satisfactory version, and asking me to reach out to University counsel if I had any further questions—just what overenthusiastic law students might think is the proper way to resolve a dispute.

Throw in a bit of, well, law-professor-like imperiousness—the journal told me it expects any article submitted to it to be ready for publication, the implication being that the journal can go to press with an author’s work whenever it wants—and Law Professor Frankenstein’s creation is complete.

Here is how events unfolded.

A few months after the pandemic hit, I found myself about twelve hours past deadline in returning final edits to Iowa Law Review. I had found a major flaw in the argument of my paper and didn’t know what to do.

Then I received this email from the managing editor: “we regrettably must move forward with publishing the piece with the previously edited version we sent.”

This is, of course, every author’s nightmare: that a journal will go to press without the author’s consent. Which is why most publication agreements have a clause like this one in the agreement I signed with Iowa Law Review: “The Work shall not be published by the Review unless the Author reviews and approves the Work.”

Authors and journals are natural partners because their interests are aligned: both are on a mission to get quality scholarship into print. The editor—and, as I later learned to my dismay, the entire Iowa Law Review—had lost sight of that mission, transforming a partnership into an adversarial affair.

What I should have done was to remind the editor of both the publication agreement and the journal’s mission to publish quality work, and to ask that the article be bumped to the next volume—or, in a worst-case scenario, withdrawn so that I could resubmit it in the summer submissions cycle.

Instead, I panicked.

I’d already been up all night trying to get the draft into shape. All I could think about was how I would feel if my flawed draft wound up in print. It was supposed to be my tenure piece.

So, rather than do the right thing, I raced madly to complete my revisions and sent an updated draft to the journal about nine hours later.

The editor replied: “Although we have already spent the balance of the day conducting the final review of the earlier version, we will accept this updated copy.”

Yes, he was so confident of the journal’s right to publish without my consent that he thought he was doing me a favor by accepting my draft.

I had almost completely rewritten the paper. The blackline I sent showed that more than half (54%, to be precise) of the text was brand new. I also attached a folder containing twenty-six new sources.

Threats aside, that should have been a red flag for the editor.

The only way for an editor to handle these changes responsibly would have been to buy time to review them by bumping the piece to the next volume—or to rescind my publication offer.

Instead, the journal went to press, explaining that “the only thing we will have time to do is check Bluebook formatting one final time and make sure nothing is egregiously out of place above the line[.]”

Of course, you can’t rewrite half an article from scratch in a few days’ time and expect it to be anything but rough.

A month after the article appeared in print, I phoned the new editor-in-chief to ask if she might be willing to swap a revised, finished draft for the current one in the Heinonline, Westlaw, and Lexis databases.

I figured she might decline to make the switch, but I thought that, regardless, she would be horrified to hear that an editor had threatened to publish my work without consent—and that she would apologize.

Instead, she sent me what might best be described as a legal memo.

“I have located and reviewed all relevant communications between you and the Iowa Law Review,” it began. Over five single-spaced pages, the memo picked through nearly all of my email exchanges with the editors over the previous year, going back nearly to the date I accepted the journal’s publication offer.

The gist of the memo was: This is your fault because you missed our deadline.

I replied that it didn’t matter who was at fault. What mattered was that a rough draft of an article had wound up in print. Something had to be done about that.

“If you have any further requests, please direct them to our university legal counsel,” the editor replied.

I was floored, of course. But I couldn’t say that my students would not have drawn the same lessons from my classes about how to conduct business as these students seemed to have drawn from their two years of legal education.

I wrote to Iowa Law’s dean, Kevin Washburn. He did not reply.

Unsure what to do next, I consulted with a colleague, who suggested I phone the faculty advisor and propose the following: The journal publishes a straw reply to my article that points out that it looks incomplete; I publish a response that explains that due to a “hiccup” in the publication process an incomplete draft of the paper had wound up in print; I attach a revised draft to the response.

The journal agreed. I thought this meant the editors had understood that threatening to publish without consent is wrong—or at least that publishing rough drafts is bad for the journal. I soon discovered that the editors again thought that they were just doing me a favor.

The following spring, after the straw reply—which I had tapped my colleague Brian L. Frye to write—had been published, the journal’s new board decided that I wouldn’t be permitted to mention the “hiccup” in my response after all.

“[W]e do not feel comfortable including the ‘hiccup’ language as from our perspective there was no hiccup in the publication process,” wrote an editor.

No, not even a hiccup.

Did the new board really understand what had happened the previous year?

Yes, I was assured. The threat to publish work without consent didn’t matter, the new editor-in-chief explained via Zoom, because (in paraphrase): “we expect that, when you submit an article to us, it is ready for publication.”

That, of course, will be news to most authors submitting articles to Iowa Law Review, not to mention the Iowa Law 2Ls slaving away checking cites.

After nearly two months, the students offered to restore my original “hiccup” language.

But I was done with the reply-response fix.

The “hiccup” language was both a whitewash of the journal’s threat to publish without consent and a pact to mislead readers about the evolution of academic debate regarding the article. It was also unlikely that a reader would find the corrected draft attached to a response to a reply to the original article.

I wanted an acknowledgment that threatening to publish without consent is wrong—a betrayal both of the author and of the journal’s readers. And I wanted to renew my request that the journal substitute a revised draft in the databases. After placing a few phone calls, I learned that Heinonline, Lexis, and Westlaw all routinely substitute new drafts for published articles. All it takes is an email from the editors.

The journal again refused.

I can think of plenty of reasons why a journal might hesitate to substitute a revised draft.

It might confuse readers. (Solution: Append an editorial note.)

It would mess up citations to the original. (Solution: Add a decimal to the new page numbers, as in 1749.1.)

Everyone might want to do it. (Solution: Limit it to victims of threats to publish without their consent.)

There’s no one available to cite-check the revised version. (Solution: Find someone. Or don’t—54% of the version that is currently in print was not cite-checked either—but that didn’t prevent the journal from publishing it when it was expedient for the journal to do so.)

But even though I begged the journal for a reason, the only one I ever got was that, as the editor-in-chief put it, “[i]t has never been Iowa Law Review’s policy to replace a published piece with an updated or revised version.”

In other words: because.

To this day, there has been no resolution. The rough draft of my article is still available in all the legal databases—and displayed on Iowa Law Review’s website—without any warning to readers regarding the unsavory circumstances of its publication. And the journal has never acknowledged that what it did was wrong—or explained to me why it will not implement a quick and effective fix.

I do think that Iowa Law Review is a troubling reflection of the lessons students absorb in law school.

Fortunately, it is not the norm.

I have worked with eleven journals. Only Iowa Law Review has treated me as an adversary—across three successive boards.

(The article as it should appear in Iowa Law Review is available here.)

UPDATE (September 12, 2022)

When I wrote the forgoing last spring, I had assumed that the buck stopped with the student editors, and that apathy and avoidance explained why the Iowa Law administration had not stepped in to put this right—after all, Iowa Law’s Dean Washburn never had responded to the email I sent him back in summer 2020.

It never occurred to me that the Iowa Law administration might approve of the students’ behavior.

I decided to write to the dean again this past July (copying the journal’s editor-in-chief and faculty adviser), only to learn that I had been naive.

The dean wrote this in reply to my message:

Thanks you for your message, Professor Woodcock. I did receive your previous message and, afterwards, I followed up with the journal.

The ILR has significant editorial independence – that is the meaning of “student-edited.”  However, I did satisfy myself that the ILR published a document that you provided.  That resolved the case for me.  I regret that I did not write back to let you know. 

When you sent your article to the ILR and asked that it be accepted and published, there was a risk that just an event might occur. I am sorry that the final result did not meet your satisfaction, but it was your work so I see no question of their integrity.

If it make you feel any better, almost every article I have published gives me a pang as I read it after publication.  I see arguments that I might have framed better, rhetoric that could have been more artful or more precise, or even an additional source that I could have cited. I think that this is one of the risks of writing for publication.

I am confident that succeeding student editorial boards have learned from their correspondence with you, but they have a new round of articles that they must work hard to publish. I encourage you to do the same. You are obviously quite thoughtful. I suspect that you have a lot more to contribute.  Thank you for reaching out. 

Kevin Washburn

Note the dean’s position:

  • If you submit an article to Iowa Law Review, you accept the risk that the editors will use threats to publish an incomplete draft without your permission in order to compel you to sign off on publication. (“When you sent your article to the ILR and asked that it be accepted and published, there was a risk that just [sic] an event might occur.”)
  • So long as the flawed draft that is published has not been altered by the editors, the Iowa Law administration sees no problem. (“I did satisfy myself that the ILR published a document that you provided. That resolved the case for me.”)

Dean Washburn’s email is a warning to scholars everywhere not to trust the quality of the scholarship that they find in Iowa Law Review. And a warning to authors that their interests count for almost nothing at this journal.

Indeed, it is remarkable to me that, despite having received two years of protestations from me regarding the quality of the article that Iowa Law Review published, neither the editors nor the Iowa Law administration has shown any interest in reviewing the substance of the article in order to understand the extent of the problems with it. Nor have either of them shown any interest in, at the very least, warning readers that the author considers the article as it appears in the journal to be seriously flawed.

One gets the impression that Iowa Law Review, and the Iowa Law administration more generally, wish to be left alone to go through the motions of running a top-ranked law review without having to concern themselves with the actual quality of what the Iowa Law Review publishes.

This is the only way to understand how the journal could use threats to compel an author to meet a deadline and still expect to receive a draft of passable quality, then waive its own quality control checks in order to rush it into print, and then refuse to update the article in the databases when the author brings his concerns about the article’s quality to them.

And what is one to make of the half-admission in the dean’s email, to wit, “I am confident that succeeding student editorial boards have learned from their correspondence with you”?

Unlike the editors, who refused to let me describe my experience as a “hiccup” because in their view “there was no hiccup”, Dean Washburn seems to think that something did transpire from which the editors might learn.

It is Accountability 101, however, that an organization will not learn unless it acts to correct its mistakes, even when doing so is costly (which it would not be in this case). And Iowa Law Review has been unwilling to fix my article.

What I find most troubling about this episode is that it is a study in organizational evasion of accountability carried out by students who are supposed to be in the process of training to ensure that the organizations of the future will take responsibility for their misdeeds—and ratified by the lead trainer himself.

If any member of the three Iowa Law Review boards with which I have dealt on this issue goes on to advise a Peloton to stonewall the Consumer Products Safety Commission after its exercise bikes start chewing up toddlers, the former law review editor will have good reason to protest that she learned how to do that at in law school. (Fortunately, the stakes of this particular lesson have been comparatively low.)

I responded to the dean’s email.

Dear Dean Washburn,

. . .

As much as everyone would like the problem here to be one of run-of-the-mill author’s remorse, those are just not the facts that we actually have.

ILR did something highly unusual and totally indefensible in this case: it threatened to publish work without an author’s consent.

Until the significance of this fact is properly appreciated, this matter cannot be properly resolved. The notion that there is no question of the journal’s integrity when it procured a draft from an author by such means is something that I think any outside observer would reject.

I have published nearly a dozen other articles and, just as you feel about your own publications, there are things I would change in every one of them. But the only journal I have ever asked to make a change is ILR.

That’s not an accident.

It’s because the journal caused me to sign off on publication of a draft that I never would have signed off upon if an editor had not threatened to publish my work without my permission. As a result, the problems with my article are orders of magnitude worse than for anything else that I have published or indeed for any article that anyone might voluntarily publish.

It’s one thing to find problems in a piece you published—they are on you—but quite another thing to find problems in a piece you didn’t want to publish but which wound up in print because an editor strong-armed you. What ILR did is so beyond the bounds of normal practice that I am confident that you have never experienced what that feels like. But if you were to experience it, you would understand why this matter is so important to me. 

ILR has never taken responsibility for this obviously wrong behavior. I can understand why a group of students would feel defensive when confronted with shortcomings in their conduct, especially when that criticism is coming from an outsider from another school. That’s all the more reason why, in a matter such as this, students need guidance from leaders within their own institution to get to a just result.

The pity of it all is that there is literally no cost at all to ILR to fix the problem—the journal can make it right with a couple of emails and move on to this volume’s crop of articles. All the more so because this problem is rooted in such an extraordinary and (I assume) unique lapse in professionalism that providing a remedy here sets no precedent whatsoever in relation to cases of run-of-the-mill author’s remorse.

Sincerely,

Ramsi

There has been no reply.

Categories
World

Talk for a Ruble

Some people think the Biden Administration hasn’t said enough to deter Russia from escalating in Ukraine. Others think the Administration has said too much to deter Russia from escalating in Ukraine.

But the problem isn’t with what the Administration is saying.

The problem is that the Administration—or, more accurately, America—isn’t willing to die either to restore America’s erstwhile sole great power status or to save Ukraine.

If America isn’t willing to die for status or for Ukraine, there’s not much America can do to deter Russia from using gas, plagues, or nuclear weapons in Ukraine.

Too Much Talk

Some Europeans—and Mitt Romney—argue that the Biden Administration’s flat renunciation of direct military intervention in Ukraine is a lost opportunity to deter Russia through “strategic ambiguity”. The Biden Administration ought instead not to make a promise about intervention either way, they say.

The trouble with this view is that it assumes the Russians take the Administration at its word when the Administration renounces direct intervention. But there is no reason whatsoever for Russia to do that. For there would be almost no consequences for the Administration were it to break its word.

If the Administration’s promise not to intervene is a promise to anyone, it is a promise to Russia, the very country the Administration would threaten to attack were the Administration to break its word. The threat to go to war would alienate Russia whether the Administration broke a promise to make it or not.

Of course, some Americans who hope for peace would feel betrayed by the Administration’s change of policy. But while the Administration surely would lose some antiwar voters, it is not at all clear that the Administration would lose them because the Administration broke a promise rather than because the Administration threatened war.

The Biden Administration’s promise not to intervene is what game theorist’s call “cheap talk”—talk for the cost of a ruble. It’s an incredible threat. The mere fact that the Administration has stated that it would not go to war to defend Ukraine erects no barrier whatsoever to an Administration decision to go to war to defend Ukraine.

If Russia is at all wise—and she may not be—she should not and will not take the Administration at its word when it promises not to go to war to defend Ukraine. It is a mistake to suppose that the Administration’s message is not already ambiguous. From the Russian perspective, it must be ambiguous.

It is more than passing naive for the Europeans—and Mitt Romney—to assume that the Administration would not lie, or change its mind.

Switching to “strategic ambiguity”—refusing to take a position on intervention—cannot help. A worthless promise not to intervene is as ambiguous as silence. There are no consequences for the Administration of breaking either.

Indeed, the only thing the Administration could say that would be credible, and so might affect the Russian calculus regarding escalation, would be to promise to intervene in the event that Russia gasses, infects, or nukes Ukraine.

That threat would be credible because a failure to abide by a promise of direct military support for Ukraine would call into question the Administration’s commitment to protecting any other ally, especially NATO members. And that in turn would prevent NATO from acting with resolve in its dealings with Russia.

So the cost to the Administration of breaking its promise would be catastrophic, creating an incentive for the Administration to abide by its promise, and so making its threat credible.

The Administration has not in fact promised to defend Ukraine because the Administration is not sure that it is willing to die for either of the things that going to war with Russia would do: restore America’s erstwhile position as the world’s sole great power or protect Ukraine.

But if the Administration were willing to die for status or Ukraine, then it would be advisable for the Administration to make the threat, because ambiguity about resolve to go to war, when such resolve actually exists, is dangerous. If Russia does not wish to go to war with the United States, then ambiguity might lead Russia to trigger a war that neither the United States nor Russia wants.

So strategic ambiguity is a bad idea all the way around. It gets the Administration nothing in the event that the Administration does not wish to go to war—because a worthless promise not to fight is no different than ambiguity—and could well cause a war that neither side wants in the event that the Administration does wish to go to war.

Too Little Talk

Some argue, by contrast, that the Administration ought to start “drawing red lines,” presumably by making explicit that the Administration will escalate if Russia gasses, infects, or nukes Ukraine.

But it is not clear that these people understand that this is not a question of words—what to say in a crisis—but rather of resolve. If the Administration draws red lines as a bluff, and Russia calls that bluff, then Russia will be able to destroy or seriously weaken NATO without firing a shot at any NATO member.

Indeed, that is what happened with the Obama Administration’s red line over chemical weapons in Syria. Russia called the Administration’s bluff, and the Administration failed to follow through, accepting a deal for Syria to destroy its stockpiles of chemical weapons as a face-saving device that fooled no one.

Coming after America’s failure to respond to the Russian invasions of Crimea and the Donbas, the Administration’s non-response put the last nail in the coffin of America’s sole great power status. Thanks to the Administration’s bluff, Russia was able to achieve this without having to fire a shot at the United States.

The Administration should only draw red lines if it has resolved to enforce them. In the context of the present war, that means that the Administration should draw red lines only if it is willing to go to nuclear war to defend them.

If not, then the Administration’s overall approach has, I think, been wise. The Administration has made a promise not to go to war that it does not need to keep.

And no promise to go to war that it cannot keep.

Categories
World

Replace the Nukes

Russia has reportedly been demanding a promise of neutrality from Ukraine in exchange for a ceasefire. Ukrainian neutrality would leave Russia better off than she is currently, for at the moment Ukraine is a Western march: allied with the West without being under the West’s security umbrella. A neutral Ukraine would not be under the Western security umbrella either, but also could not act as a Western ally in military affairs.

But neutrality is not just something that a country declares.

To be neutral, a country must posses sufficient resources to defend herself against all potential attackers. If not, then, even if she declares neutrality, a threat will cause her to seek help from others, and her neutrality will disappear. Switzerland and Finland were able to be neutrals in the 20th century because they are hard to dominate. Switzerland is defended by her mountains. The Finns showed their capacity for self defense in the Winter War.

So, how to make a Ukrainian promise of neutrality credible?

Replace her nuclear weapons, and give her the means to launch them. When the Soviet Union collapsed, Ukraine had about 1,700 nuclear warheads. In 1994, she agreed to destroy them in exchange for a Russian promise “to refrain from the threat or use of force against the territorial integrity or political independence of Ukraine.” It is only just that, given Russia’s breach of promise, Russia should restore Ukraine to the nuclear position Ukraine once occupied.

But not only is it just, it is also good for Russia. For a nuclear Ukraine would have the resources to defend herself against all potential attackers, making her a true candidate for neutrality.

Today, Ukraine is a Western march because Ukraine needs Western help to defend herself against Russia. In exchange for that help, she must be willing to tolerate a Western military presence on her soil (indeed, she is begging for that presence). If Ukraine continues to be a Western march after the war, Russia can be certain that Ukraine would permit the West to transit through Ukrainian territory en route to attacking Russia.

But if Ukraine were to have nuclear weapons after the war, then Ukraine would no longer need the West to help her defend herself against Russia. And if Ukraine would not need the West, the likelihood that she would allow the West to transit through her territory en route to making war against Russia would be reduced. Indeed, given the potential for such an attack to spiral into a nuclear conflict, and the fact that Ukraine would then have nuclear weapons and so be a natural target of Russia in such a conflict, Ukraine would have a strong incentive to preserve her neutrality and not to permit such transit.

Nukes mean independence. And independence is a prerequisite of neutrality. If all Russia seeks from Ukraine is neutrality then it is in Russia’s interest to reward a Ukrainian promise of neutrality not just with a complete withdrawal of troops from Ukraine but with 1,700 free nuclear weapons, and the means to launch them—both at the West, and back at Russia.

If Russia won’t consider renuclearizing Ukraine, then Russia’s demand of neutrality is not sincere. Indeed, if the reports that Russia is also demanding demilitarization are correct, then what Russia really wants is to make Ukraine a Russian march—a territory through which Russia can transit at will but to which Russia need make no promises—for example, of mutual defense—in exchange for that power.

Categories
World

European Marches

There is nothing so helpful to national defense as a borderland. In Europe, these were called marches. The fight over Ukraine is a fight for a march, and this explains why the West is reluctant to intervene militarily.

You can dig moats, build walls, and buy tanks, but none of these will raise your rivals’ costs of attacking you quite like a march.

A march puts space between you and your enemy, and so forces your enemy to cross that space to reach you, costing time and energy. The Germanic tribes maintained tracts of empty territory along the East bank of the Rhine for this purpose. Roman armies had to cover much territory before they could harm them.

But often a march gives you something even more valuable: people willing to fight and die to keep your enemy out of the march—people who aren’t yours, and whose deaths cost you nothing. People who are expendable.

But also loyal. You can send your own armies through a march unmolested. But the population will make your enemies pay for every square inch they wish to cross. A march facilitates your offense and substitutes for your defense. It is at once the least expensive and most effective form of protection available to a great power.

Post-Soviet Ukraine has long been in danger of becoming a march. After the collapse of the Soviet Union she did not join the mutual defense pact of the former Soviet states. Because that pact would have obligated Russia to come to her aid in the event of invasion by the West, it would have made her a part of Russia, in the sense that an attack on her would have been an attack on Russia. But Ukraine also did not become a part of NATO or the EU. She belonged to neither, which meant that she could become a march of either.

Russia seems to have thought that she could make a Russian march out of Ukraine. But, after 2004, or at any rate 2014, when Russia first attacked Ukraine, Ukraine became a Western march instead. She welcomed Western military aid and no doubt would have been delighted had the United States offered to station troops in her territory. But she would have, and indeed was, fighting any Russian encroachment upon her territory whether she received support from the West or not.

Thus between 2004 and 2014, the West received a windfall in the form of a march that it had obtained for free thanks to the aspirations of Ukrainians to ally themselves with the West as opposed to Russia.

The West will not intervene militarily to stop Russia’s current invasion of Ukraine because the West is better off letting Ukraine do the West’s fighting for it. That is the advantage of having a march. Why should the West give it up? If the West is not thinking this way, it is, at any rate, acting this way; its refusal to go to war to protect Ukraine is, clearly, selfish.

The alternative to having a march is exposing yourself to your enemy, which is why marches are always better if you can get them. If the West had undertaken to guarantee Ukraine’s security against Russia, then Ukraine would have become the West, and a strike by Russia at Ukraine would have been a strike directly at the Western belly, with all of the danger that entails.

The West is held together by mutual defense pacts—those between NATO members and those between European Union members. A failure to defend a member calls the entire union, and hence the existence of the West itself, into question. Unity may be difficult to muster with the threat of nuclear war hanging over the decision.

How much safer the West is in keeping its belly tucked safely behind Ukraine! The Russian invasion of Ukraine does not force the West to prove its unity or strength on the battlefield.

So when a Ukrainian says to the West: “what is the difference between sending us guns or volunteer soldiers and deploying your tanks directly against Russia?”, the West’s answer is: cost. It is far less expensive and less risky for us if you do the fighting for us.

Bleed Russia until her government collapses. Bleed her until her people lose the will to fight. Bleed her until she lacks the ability to fight. So we will never have to face her directly.

And Ukraine is compelled to respond: “nevermind; we will defend you gladly, and for free!” For Ukraine is in the terrible position occupied by nearly all marches: she fears one neighbor more than the other, and the other neighbor knows it.

What makes Ukraine a Western march and not a Russian march is that she fears Russia more than she fears war. So she has no leverage in negotiating the terms according to which she defends the West.

She cannot say to the West: “give us a share of the vast savings in blood and treasure that we confer upon you by doing your fighting for you; if you do not, we will not fight for you.” The West would know this to be a bluff. Ukraine will fight Russian aggression whether the West helps or not, and so she cannot hope to appropriate any of the benefits that her self-defense incidentally confers upon the West.

Comparison with Poland in 1939

What Ukraine would have needed in order to avoid becoming a march is what Poland thought she had in 1939: a third party to guarantee her safety.

Poland was sandwiched between Germany and Russia. Rather than become a march to either, she entered into an alliance with the West—that is, Britain and France—which undertook to guarantee her security.

If this guarantee had been credible, then if Germany had wanted Poland as a march against Russia, Germany would have had to pay Poland a pretty penny for her aid. Indeed, Germany would have had to guarantee Poland’s security, since that is what the West was already doing, meaning that Germany would not really have been able to make a march of Poland at all, at any price. And if Russia had wanted Poland as a march, Russia would have had to do the same and more, in order to outbid Germany.

In the event, however, neither Germany nor Russia considered the Western guarantee to be credible. And although the guarantee turned out to be real enough in the end, in the sense that Britain and France did declare war on Germany when Germany invaded Poland, it turned out still to be false as a practical matter, because World War Two never did save Poland. She regained her freedom from Russia only with the collapse of the Soviet Union.

Despite the incredibility of the Western guarantee, Germany and Russia ought, nevertheless, to have been content to let Poland alone, acting as march to neither. For, unlike Ukraine, which fears Russia more than the West (if she fears the West at all), Poland feared both Russia and Germany and would have, and did, fight the encroachments of both. That fact of mutual animosity provided some safety to both Germany and Russia vis a vis each other—a protective buffer between two powers—even if less than the safety that would come to one from having Poland as a march against the other.

But instead Germany and Russia decided to divide Poland up between themselves, thereby exposing themselves to each other. Russia learned shortly just how unwise it is for a weaker power to expose herself directly across a border to a stronger power. And of course the dividing up triggered the Western declaration of war, which, though it could not save Poland, ultimately was Germany’s undoing.

Marchdom for Ukraine Is a Departure for the West . . .

The West’s decision to treat Ukraine as a march flies in the face of decades of Western post-Soviet policy toward the West’s borderlands with Russia. For whenever the West has had the opportunity to swallow its marches—by promising to defend them, and hence incorporating them into itself—it has.

If one starts from the north and works down the European border with Russia, one encounters, first, Finland, which was non-aligned during the Cold War, relying on the lesson in military resilience that it taught both the Soviets and the Germans during World War Two to operate as a neutral—a country that buffers both sides by being willing to fight encroachment by either, but which allies with neither and so cannot be considered a march.

When the EU adopted its mutual defense clause in 2009, Finland, which had joined the EU in 1995, stayed on in the union. She became dear to the West. Not a march—for the West now was obligated to treat her as a limb and come to her aid in the event of attack, lest the West itself shatter through a show of disunity. The West, then, had exposed itself to Russia directly across a land border, and indeed caused Russia to be exposed to the West directly across a land border.

It did not stop there. Moving south, we next encounter the Baltic states, all three of which joined both the EU and NATO in 2004, obligating the United States, and not just Europe, to come to their aid in the event of a Russian attack. Here again the West had exposed itself to Russia directly across a land border and caused Russia to be exposed to the West directly across a land border as well.

Belarus is next. She belongs to Russia’s mutual defense organization, the CSTO, which makes her dear to Russia—not a Russian march but a Russian limb. To her south, we find Ukraine, to which the West seemed willing to give NATO membership as late as 2008, but no longer, making her a Western march.

. . . Because Russia Used to Be a Middle Power

Why was the West so willing for so long to expose itself directly to Russia across its long borders with her; and why has the West now changed its mind and chosen to make Ukraine a march rather than to incorporate her via NATO membership?

The answer is that from 1991 until perhaps 2014, the West thought Russia was a middle power. She still had a vast nuclear arsenal, to be sure, and plenty of means of using it. But she seemed to have lost the mindset of a great power, just as France, Germany, Japan, and Britain had done before her.

You let your belly hang out when you think you are safe, and the West thought it was now safe. Not so safe, perhaps, as to do away with mutual defense pacts, but safe enough not to bother to create marches against Russia.

And the West could have created marches. Finland could have been made to continue to play the buffer role that she had played throughout the Cold War, by ejecting her from the European Union when the mutual defense clause was adopted, or by not adopting that clause and continuing to reserve to NATO responsibility for mutual defense. Finland’s closeness with the West might have made her accept march status; but even if she had insisted upon returning to her Cold War neutrality the West would have been much less exposed to Russia along the Russo-Finnish border than the West is now.

Each of the Baltic states would, certainly, have been willing to be a Western march. Each would have been willing to fight Russia regardless whether the West made a commitment to protect her. The Baltic states loathe Russia and fear her far more than they fear war. They will take all the Western help they can get. The West could have denied them NATO membership without losing their loyalty.

But it was only in 2014, after the West had gone belly to belly with Russia in Finland and the Baltic states, that it became clear to the West that Russia had reacquired a great power mindset, and so the West did not think to make marches of Finland or the Baltic states.

Perhaps Russia’s 2008 war with Georgia signaled the change in her mindset well enough to careful observers. Russia’s 2014 annexation of Crimea, followed by Russia’s wars in the Donbas and Syria, made it clear to the world.

The West Could Have Responded to a Resurgent Russia By Defending the West’s Status as Sole Great Power

The West could have responded in one of two ways.

First, it could have insisted upon the sole great power status that it had enjoyed since the collapse of the Soviet Union in 1991. To maintain that status, the West would have had to continue to treat Russia as a middle power, for the world’s sole great power can deal only with middle powers.

In this case, the West would have continued to pursue NATO membership for Ukraine—to demonstrate the hollowness of Russia’s attempt to reassert great power status by exposing the West’s belly to Russia. The message would have been: “go ahead, make my day.” It would have been a challenge to Russia to prove to the world that she was in fact able to go toe to toe with the world’s sole great power.

The West would have rushed troops to Ukraine in the wake of the Crimea annexation, rushed them again to the Donbas, and rushed them again to Syria, seeking to eject Russian forces in all three cases. Middle powers are not permitted international adventures without the consent of the sole great power.

This would, to be sure, have created a risk of nuclear war. But the world’s sole great power does not fear war with a middle power more than the world’s sole great power fears loss of status. To the contrary, the ultimate test of a great power—or, in this case, of a sole great power—is a willingness to go to war—to risk everything—to maintain status.

The West did not do these things, and in not doing them, the West conceded to the world that it was not the world’s sole great power anymore, but merely one among two—indeed, given China’s strength relative to Russia, necessarily three—great powers.

One should not forget the importance of that moment in 2014 when the West failed to respond to Crimea. For a quarter century before that time, the West had been the only global actor. Its status as sole great power was taken for granted. With the non-response to Crimea, that image disappeared and talk of great power competition reappeared after a decades-long hiatus.

The West in Fact Responded by Conceding Renewed Great Power Status to Russia

But even if the West had conceded its status as sole great power, it remained a great power. Its second Crimean response option was consistent with that great, but not sole-great, power status.

The West could take steps to defend itself, one great power from another, in ways familiar to students of great power competition throughout history: to put marches between itself and the enemy. The West took that option by demurring on NATO membership for Ukraine after 2014, and is continuing that policy by refusing to go to war with Russia on Ukraine’s behalf today.

The West has abandoned its policy of going belly-to-belly with Russia and is now making marches because the West has conceded Russia’s claim to renewed great power status. The West no longer sees itself as staring down a middle power but rather as erecting defenses against a great power.

Thus, it is entirely fair to say that the failure of the West to go to war to defend Ukraine is a sign of weakness. It reflects loss of sole great power status. If the West wished to maintain that status, it would have had to go to war with Russia after Crimea, and certainly, now, in response to the invasion of Ukraine.

It is entirely fair as well to question whether the West’s failure to defend Ukraine is a mistake. For there were plenty of advantages associated with being the world’s sole great power.

Most notably: security.

In a world in which any middle power seeking to adopt a great power mindset and so to raise herself to great power status were threatened with overwhelming, nuclear force by the West, one might expect such challenges from middle powers to dwindle and disappear over time. And uncontested power brings peace—to everyone except the victims of the sole great power itself (let us not forget Iraq).

Of course, threatening nuclear-armed states risks nuclear war.

But, again, great power status can be maintained only if one is willing to die for it. Russia has been able to claw back her lost great power status only by taking such risks. If they perhaps seemed small in the context of Crimea, the Donbas, and Syria, the danger Russia currently runs of defeat in Ukraine and collapse at home shows how much she has been willing to risk to reacquire her status.

To maintain its sole great power status, the West would have had to do the same. And, if the poor performance of Russian forces in Ukraine is any measure, it appears that Russia would have stood no chance against the West in a conventional fight over Crimea, the Donbas, or Syria. Unless she were willing to risk nuclear annihilation, Russia might well have withdrawn in the face of a determined foe.

Loss of Sole Great Power Status Aside, the West Is Strongly Playing a Strong Hand

It is also fair to say that, if the West is content to relinquish its status as sole great power, then the West’s failure to come to Ukraine’s aid is in the West’s interests and not a sign of weakness at all. What’s more, if Russia wrecks herself on the Ukrainian rock, she will lose her great power status and the West will gain status by default, though not a return to sole great power status given the West’s passive response to Russian intervention in Ukraine and the continued viability of China.

It is in a great power’s interest to allow her enemies to bleed themselves dry fighting in her marches. It is in the West’s interests to let others—here, the Ukrainians—do their fighting for them. Assuming, again, that the West is content to let the world see Russia as a great, rather than a middle, power.

Mearsheimer Is Wrong

This also provides a complete response to John Mearsheimer’s contention that Crimea, the Donbas, and the invasion of Ukraine are all the West’s fault. It is Mearsheimer’s contention that if the West had not come to view Russia as a middle power after the collapse of the Soviet Union and had instead treated her like a great power, then the West would not have sought to make Ukraine a NATO member and so Russia would not have felt compelled to attack Ukraine.

What Mearsheimer misses is that, given Russia’s bid to return to great power status, the only way war could have been avoided is if Ukraine had submitted to incorporation into Russia via participation in the CSTO’s mutual defense pact, a la Ukraine’s neighbor Belarus. All other outcomes are either impossible or lead to war.

But Ukraine would never have submitted to such a thing. Indeed, it is a remarkable fact that Ukraine never even joined the Commonwealth of Independent States when it formed in 1993 because she objected to the position of the CIS charter that Russia was the only legal successor state to the Soviet Union. Ukraine also never joined the CSTO’s predecessor.

Russia would also have been satisfied if Ukraine had become a Russian march. But for that to happen Ukrainians would have needed to fear the West more than they fear Russia, which Ukrainians manifestly do not. Only a war aimed at breaking the will of the Ukrainian people, such as Russia has launched now, would change this.

Russia might also have been satisfied if Ukraine had become a neutral country—non-aligned in the style of Finland during the Cold War. But neutrality is possible only if a country fears all the powers on its doorstep more or less equally. Ukraine, however, fears Russia more than the West. Given this asymmetry of fear, the natural position for Ukraine to occupy even were the West never to have offered NATO membership to her would be that of a Western march—precisely the position that Russia has proven herself willing to go to war to stop.

What Mearsheimer misses, as well, is that, from his own realist perspective, the present war in Ukraine is a victory for the West.

That is, Mearsheimer does not seem to think that the West could maintain its sole great power status. Instead, Mearsheimer sees the conflict between Russia and the West as a matter of competition between great powers. In that case, the best possible outcome for the West is to have Ukraine become a march—which she has—and then to have Russia throw herself upon that march and bleed dry, which she is doing. Even if Russia wins the war, she emerges weaker. And it is far from certain that she can win the war.

The war is a calamity for Ukraine and for humanity; but not for a West that sees itself as one of several great powers.

What is more, Mearsheimer’s view suffers from hindsight bias. It was not at all clear in 2000 or 2004 that Russia would ever regain her erstwhile great power mindset. She could very well have chosen to join the ranks of former great powers content to grow rich on international trade and follow the direction of the West.

If she did not go to war to stop the Baltic states’ incorporation into NATO in 2004 or to prevent Finland from joining the EU’s mutual defense pact in 2009, why should the West have supposed that she would go to war in 2014 to stop the incorporation of Ukraine into the West? (Well, Russia’s invasion of Georgia in 2008 was some warning, but Georgia is a small country. )

Great power status is not something that can be measured in terms of nuclear weapons, GDP, or numbers of tanks alone. It is not the case that Russia always was a great power and should have been treated accordingly throughout the 1990s and 2000s. Great power status is a mindset; a way of acting. Russia did lose it in 1991.

Russian Policy Toward Ukraine Has Been Folly

It is also fair to say that, while Russia’s policy toward Ukraine since 2014 has been wildly successful at demoting the West from the status of sole great power, it has been utter folly from the perspective of competition between great powers.

For Russia is better off going belly-to-belly with the West across the land border between Russia and Ukraine than it is facing a Western march in Ukraine. But Russia’s annexation of Crimea and intervention in the Donbas prevented NATO from swallowing Ukraine and made a march out of her instead.

A march is altogether a more dangerous thing for Russia than is having her enemy at her gates, because the enemy can attack you through a march but you cannot attack your enemy through the march. When you have your enemy at your gates, by contrast, you can attack your enemy directly.

If Ukraine had joined NATO, and Russia had only then annexed Crimea, or started trouble in the Donbas, or, indeed, launched the present total invasion of Ukraine, and the West had failed to declare war upon Russia in response, then the West would be utterly shattered. NATO’s mutual defense pact would be a dead letter and Eastern Europe would be forced to accept Russian power in the region. NATO expansion brings menace to Russia’s borders, but it also brings Western vulnerability to her borders.

Instead, Russia annexed Crimea and started trouble in the Donbas before Ukraine could become part of NATO, and so before Ukraine could expose the Western belly. And Russia’s annexation of Crimea and starting of trouble in the Donbas worked to convince the West not to expose herself to Russia, to delay NATO membership indefinitely, and to turn Ukraine into a Western march.

Now Russia’s total invasion of Ukraine strikes no blow at the West at all, but instead becomes an unparalleled opportunity for the West to bleed Russia dry. Russia’s armies are tied up in brutal fighting. Russia’s economy is wrecked. But the failure of the West to go to war with Russia does not shatter the West, because there are no Western promises to Ukraine to break. And no matter how many Ukrainian soldiers Russia kills, not a single Western soldier is harmed. This is why a march is a great power’s best defense.

And why a great power that has any wisdom at all does not undertake to invade a march.

This is also why Anders Fogh Rasmussen is quite wrong to say that if Ukraine were to forswear NATO membership in order to obtain peace from Russia then that “would de facto make Ukraine a part of Russia, like Belarus.”

On the contrary, if that were all that Ukraine were to agree to do, then that would make Ukraine a permanent Western march—the absolute worse possible outcome for Russia, although it is not clear that Russia herself is aware of this.

Of course, it would not be in the interest of Ukraine to make such a concession, because that means agreeing to suffer for the safety of the West in perpetuity. Ukraine would be much better off insisting upon and obtaining NATO membership, so that the West will guarantee her safety.

Indeed, so long as Russia is considered a great power, the only beneficiary of a Western refusal to grant Ukraine NATO membership is the West.

The Conditions Required for a Pyrrhic Victory

It is impossible for the present Russian invasion of Ukraine to become a success for Russia. The poor performance of her military is a humiliation, one that has greatly set back her ambitions to reassert her great power status, and if she loses the war—a real possibility—she will return to the ranks of the middle powers. If she wins the war she may remain a great power, but only barely; it will be a pyrrhic victory.

It would be a mistake, however, to suppose that if she prevails militarily she will be unable to hold onto Ukraine due to the depth of anti-Russian sentiment among Ukrainians. If Russia is not constrained by public opinion—and it seems that she is not—then she will be at liberty to kill any Ukrainian who resists, and so to alter Ukrainian society. History is littered with tales of conquered peoples who go on to collaborate with the invader—so long as the invader is cruel enough.

It was the conquered Mexica themselves who rebuilt Tenochtitlan for Cortes.

Once he had conquered Gaulish armies, Caesar seems to have had little difficulty controlling the Gauls. Everywhere he went, he spared those who submitted fully to Roman rule and sold the rest into slavery or put them to the sword. Having beheld the complete destruction of their world, those who remained—and they remained because they had shown a willingness to submit—became Romans.

Moreover, Russia was able to control deeply unhappy populations all across Eastern Europe during the Cold War. And Russia has succeeded at doing so more recently in quelling resistance in Chechnya, which Russia now so dominates that Chechen troops are fighting on the Russian side against Ukraine.

Russia’s indiscriminate shelling of Ukrainian cities is not only meant to help her troops advance into them. It is also meant to prepare the Ukrainian people for submission.

If Russia is entirely successful, then she will make a Russian march of Ukraine. If she is only moderately successful—if Ukraine retains some independent spirit—then Russia will be forced to incorporate Ukraine, either because she must occupy Ukraine permanently or because she cannot expect Ukraine to fight her enemies on her behalf without tying Ukraine more closely to herself.

Russia would be better off making a march of Ukraine. But incorporating Ukraine would leave Russia better off than before the war, for now a Russian vulnerability to a Western march on the Russian-Ukrainian border would have been converted into a mutual Russian vulnerability and a European vulnerability on the Ukrainian border with NATO-member Poland.

But Russia will be no better off than if she had desisted from annexing Crimea and attacking the Donbas in 2014 and thereby allowed Ukrainian membership in NATO to become a reality. That would have created the same mutual vulnerability across a land border. True, in the event that the invasion is a success, the mutual vulnerability will exist across a land border nearly 800 miles further West. But the cost to Russia of winning is likely to be so large as to cancel out that improvement.

Russia Has So Few Marches of Her Own Because She Is Feared

A country aspiring to a return to great power status ought not expose her belly to her enemy in the way that a power that pretends to sole great power status might expose her belly to a middle power.

Russia has not, however, been able to avoid doing that in the post-Soviet years, because her weakness makes it difficult for her to maintain marches, and if you are not blessed with neutral powers to act as buffers, the next best thing to a march is to incorporate the territory. You expose yourself, but you deny the territory to your adversary.

The West has been able to maintain Ukraine as a march because Ukraine fears Russia more than she fears the West (if she fears the West at all). Russia has not been able to do the same with her satellites because they do not fear the West more than they fear Russia. If Russia tries to maintain them as marches without giving them security guarantees, then they may well defect to the West (or Russia will be forced to invade and break them, as she is trying to do with Ukraine).

As a result, Russia has been forced to go belly-to-belly with the West not only along her borders with Finland and the Baltic states, a situation foisted on her by Western decisionmaking. She has also gone belly-to-belly with the West across Belarus’s borders with the Baltic states and Poland, because she has been forced to give Belarus security guarantees in order to keep her in the fold, and so has incorporated Belarus.

Going belly-to-belly with the West along the border between Ukraine and Poland would not, therefore, be much of a departure for Russia, and, again, it is better for her than facing a Western march along her border with Ukraine.

But all this assumes that Russia can win the war. She may not.

And one hopes that she does not.

Categories
World

Embargoing the Economics

Lipsky argues if the West were to ban Russia’s energy exports, it would drive up energy prices in a way which would benefit the Russian economy rather than hurt it. He said Russia would find other buyers for its energy, such as in China, and it would have more cash coming in, not less.

Chris Isidore, Russia’s Economy is Surprisingly Tiny. Here’s Why It Matters so Much to You, CNN (Feb. 26, 2022).

This is a deeply flawed assessment of the likely effects of an energy embargo on Russia.

If an energy-embargoed Russia were only able to trade with China, then an energy-embargoed Russia would not be able to insist that China pay the world market price for natural gas.

Russia would only be able to insist that China pay the world market price if Russia could threaten to access world natural gas markets in the event that China were to refuse to pay the world market price. But, because of the embargo, Russia would not be able to make such a threat.

Instead, an energy-embargoed Russia would negotiate with China from a position of extreme weakness, just as, for example, Britain negotiated with the United States from a position of extreme weakness during World War Two.

Due to Hitler’s capture of Europe, Britain’s only real trading partner for war materiel was the United States. We insisted on prices that nearly bankrupted Britain; she rationed food until 1950 in part to pay off her debts. This despite our being an ally with interests that were more or less aligned with Britain’s.

China and Russia are, by contrast, neighboring great power aspirants that have fought with each other in living memory. China would surely insist on very low prices for the gas, or other terms designed to weaken her latent adversary or put Russia into a position of long-term dependence on her.

No, it is not any question about efficacy vis a vis Russia that counsels against an embargo. It is the suffering that it would cause to the rest of the world.

China imports 50 billion cubic meters of natural gas per year, Russia exports 200 billion cubic meters per year, and global yearly imports by all countries are 960 billion cubic meters. It follows that, after accounting for the natural gas that would be freed up on the world market by Chinese purchase of discounted gas from Russia, the embargo would wipe out about 15% of global natural gas supply.

Someone is going to have to go without, and in the short run it would be Europeans, given that alternative sources of supply have already been contracted out to others. Closing airspace and lighting up buildings in blue and yellow is rather less costly.

The liberal internationalists who said that trade would bind powers together and so reduce conflict weren’t wrong.

But an important corollary is that you have to be willing to use the leverage that trade gives you. Threats only work if they are credible.

That means being willing to suffer.

Categories
World

Europia

One wonders whether a massive buildup of troops in Alaska—or the Pacific theater more generally—would not have been a more powerful deterrent given how many units Russia had to transfer from the Far East. Would Russia risk nuclear war to protect her sparsely populated eastern wastes? She would, I think, have felt compelled to maintain more conventional forces there, reducing the numbers available for Ukraine. That might also have deterred China, in case she is planning on surprising us by piggybacking Taiwan on Ukraine.

Granted, it would have been cheap talk. The United States do not, I think, fear loss of status more than they fear war these days.

Categories
Antitrust Monopolization

Antitrust Preemption

The best way to regulate the tech giants is to tax the immense scarcity rents they generate. Instead of doing that, the Biden Administration has gone all-in on antitrust action, which can’t touch those scarcity rents, even if antitrust action does succeed at making tech markets more competitive, which is unlikely.

When I make this point, people tell me: “don’t worry! Taxation and antitrust action aren’t mutually exclusive. The Biden Administration is also pro-tax.”

Well, is it?

The Canadians are planning on taxing the tech giants, and instead of rushing to complement this sound policy, by imposing our own tax, the Biden Administration is threatening to retaliate if they don’t scupper their plans.

An administration, like everything else, has a budget constraint, denominated in attention as well as dollars. If it is going all-in on one thing, it’s not going all-in on another.

And to go all-in on one policy, an administration may need to reject others in order to maintain the coherence of the one it favors, which seems to be happening here. The Biden Administration is complaining that it’s unfair for Canada to single out American tech companies for taxation, something that would have less bite if America were singling them out itself.

So, please don’t tell me that yes, you agree that antitrust probably can move the needle only very slightly, if at all, but why not try it anyway?

If you’re trying it, you’re not trying the stuff that actually works.

Categories
Civilization

Not Without Precedent

A massive troop buildup followed by an ultimatum and then an invasion based on a totally absurd and completely made-up pretext, while the international community looks on in reproach and horror.

That was our invasion of Iraq in 2003.

We didn’t have a dictator to blame it on. A whopping 72% of Americans supported the war. And reelected its instigator the following year in free and fair elections.

One hopes that it doesn’t end as badly for Ukraine.

Update:

Putin “has chosen a premeditated war that will bring a catastrophic loss of life and human suffering,” President Biden said in a statement that called the Russian operation an “unprovoked and unjustified attack.”

“Russia alone is responsible for the death and destruction this attack will bring, and the United States and its Allies and partners will respond in a united and decisive way. The world will hold Russia accountable,” he said.

https://www.washingtonpost.com/world/2022/02/23/russia-ukraine-updates/

Well, we, too, chose a “premeditated war that [brought] a catastrophic loss of life and human suffering.” President Biden voted for it when he was a Senator.

We have never been held to account.